V. 10:9 (399-401): Breaking Out Of The Trading Range by John Sweeney

V. 10:9 (399-401): Breaking Out Of The Trading Range by John Sweeney
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Breaking Out Of The Trading Range by John Sweeney

Some blessed day, after being mired in a trading range for two years, your market is going to finally go into a trend. You must be there when it does, not trading something else or, worse, ignoring it from the golf course. Ideally, you've been trading the range back and forth trying to avoid losing money and possibly even making a little. You've been selling the tops and buying the bottoms as best you can, waiting for a breakout. How can you tell if it's happened?

Graphically, as in Figure 1, you are waiting for a trade that hits your maximum adverse excursion (MAE) stop. To refresh your memory, MAE is the amount that winning trades go against you. Beyond that point, your expectation is that the trading range trade will be a loser. If it is, then mightn't it be a winner if reversed? When is a breakout far enough from the trading range to be legitimate? Answer: when experience shows that it's moved far enough to become a loser as a trading range trade.

Last month, when analyzing trades back into the range, I defined a simple test for nontrending behavior in Treasury bonds plus some simple rules for entry and exit. I also measured how far wrong these trades went and arrived at the conclusion that, for this tradeable Treasury bond futures and this trading rule, $1,500 would have to be risked before reversing. This turned out to work fairly well in recent bond trading, but now I need to test a variety of data to see what happens when that $1,500 loss is taken and a reversing trade, with any luck into a trend, is entered.

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